CHAPTER 1 The Individual Income Tax Return Income Tax Fundamentals 2011 edition Gerald E. Whittenburg Martha Altus-Buller Student’s Copy 2011 Cengage Learning

Objectives of Tax Law  Raise revenue  Tool for social and economic policies ◦ Social policy encourages desirable activities and discourages undesirable activities  Credits for investment in solar and wind energy  Can deduct charitable contributions  Credits for higher education expenses ◦ Economic policy as manifested by fiscal policy  Encourage investment in capital assets through depreciation ◦ Both economic and social  Exclude gain on sale of personal residence up to $250,000 ($500,000 if married) 2011 Cengage Learning

Primary Entities/Forms  Individuals ◦ Taxable income includes wages, salary, self- employment earnings, rent, interest and dividends ◦ An individual may file the simplest tax form that he/she qualifies for  1040EZ  1040A  1040  If error made on one of the three above forms, can amend with a 1040X Cengage Learning

Tax Formula for Individuals This model follows Form 1040 Gross Income less:Deductions for Adjusted Gross Income [AGI] AGI less:Greater of Itemized or Standard Deduction less:Exemptions Taxable Income times:Tax Rate Gross Tax Liability less:Tax Credits and Prepayments Tax Due or Refund 2011 Cengage Learning

Standard Deductions & Exemption 2011 Cengage Learning 2010 standard deduction ($) Single 5,700 Married Filing Joint (MFJ) 11,400 Qualifying Widow(er) 11,400 also known as Surviving Spouse (SS) Head of Household (HOH) 8,400 Married Filing Separate (MFS) 5,700 *Taxpayers 65 or older and/or blind get an additional amount $1,100 if MFJ, MFS or SS $1,400 if HOH or Single 2010 exemption$3,650 – personal & dependency

Filing Status  Single ◦ Unmarried or legally separated as of 12/31 ◦ And not qualified as married filing separately, head of household or qualifying widow(er)  Married Filing Jointly (MFJ) ◦ If married on 12/31 – even if didn’t live together entire year ◦ Same-sex couples may not file jointly ◦ If spouse dies during year you can file MFJ in current year  Married Filing Separately (MFS) ◦ Each file separate returns ◦ Must compute taxes the same way - both itemize or both use standard ◦ If living in community property state, must follow state law to determine community and separate income 2011 Cengage Learning

Filing Status  Head of Household (HOH) ◦ Tables have lower rates than single or MFS ◦ Taxpayer can file as HOH if:  Unmarried or abandoned* as of 12/31  Paid > 50% of cost of keeping up home that was principal residence of dependent child or other qualifying dependent relative  There is one exception to principal residence requirement. If dependent is taxpayer’s parent, he/she doesn’t have to live with taxpayer. Note: A divorced parent who meets above rules and has signed IRS/legal document, may still claim HOH even if dependency exemption shifted to ex-spouse 2011 Cengage Learning *See pages 1-10 and 1-11 for requirement for abandoned spouse

Filing Status  Qualifying Widow(er) with Dependent Child ◦ Also known as surviving spouse ◦ Available for two subsequent years after death of spouse  Must pay over half the cost of maintaining a household where a dependent child, stepchild, adopted child or foster child lives ◦ Gets benefits of married filing joint tax rates 2011 Cengage Learning

Personal/Dependency Exemptions  Personal exemptions may be taken for self and spouse  Additional exemptions may be taken for individuals who are either taxpayer’s ◦ Qualifying child or ◦ Qualifying relative  For 2010 each exemption = $3,650 In years prior to 2010, exemptions phased-out for high- income taxpayers. It is anticipated that the phase-out will be reintroduced in Cengage Learning

Capital Gains/Losses  A capital asset is any property (personal or investment) held by a taxpayer, with certain exceptions as listed in the tax law ◦ Examples: stocks, bonds, land, cars and other items held for investment ◦ Gains/losses on these assets are subject to special rates  Holding period of asset determines treatment ◦ Long-term is held >12 months (taxed at capital rates – see next screen) ◦ Short-term is held <= 12 months (taxed at ordinary rates) 2011 Cengage Learning